people at restaurant counter

IRS targets tip income reporting of food and beverage establishments

Discussions in our nation’s capital currently center on debt, and therefore naturally involve discussions about tax revenues. The Internal Revenue Service (IRS) is doing its part, and has begun to increase its efforts to root out and capture lost revenues in the form of unreported income taxes and FICA (social security and Medicare) taxes, with a particular eye on the hospitality industry.

In 2006, the IRS calculated the annual tax gap to be approximately $290 billion based on 2001 data. How does this impact the hospitality industry? Of this total, the IRS estimated the portion related to unreported tip income to be approximately $11 billion. The IRS intends to close this portion of the tax gap by actively targeting hospitality companies with large food and beverage establishments for examination activity.

Common pitfalls to avoid

Hospitality companies with large food and beverage establishments are required to annually file Form 8027, Employer’s Annual Information of Tip Income and Allocated Tips. This is the primary way the IRS tracks tip reporting compliance. The IRS believes it should be receiving between 150,000 and 200,000 of these forms annually; however, the IRS has communicated that figure is currently only 50,000 to 60,000. Therefore, the IRS knows there are a significant number of hospitality entities that are not in compliance and has an outside contractor to help identify non-filers of this form.

Many food and beverage providers have falsely concluded that a tipping rate of 8% provides some level of "safe-harbor." But in fact, the exact opposite can be true. The IRS expects tipping rates at most tipping venues to be much greater than 8%. The law requires employees to report 100% of their tip income, whether via credit charges or cash.

Large hospitality companies can even be trapped when the Form 8027 is annually filed. For example, the form is organized in such a manner that readily identifies for the IRS when an employer is using a flat 8% safe-harbor approach. The form can serve as a "flag" to the IRS, suggesting that the employer is ripe for a tip reporting examination. A large food and beverage establishment can be "flagged" for examination in one of two general ways – (1) not filing the required Form 8027, or (2) filing the required Form 8027, but doing so with a tip rate that the IRS believes is below industry standards.

A Baker Tilly tip

Hospitality companies with large food and beverage establishments should review their tip reporting procedures and educate employees about proper tip reporting. Getting your house in order before the IRS knocks at the front door is a key step to mitigating any issues upon examination, or possibly avoiding an examination in its entirety.

Baker Tilly’s hospitality industry specialists can help your organization mitigate risk related to tip income reporting. We are experienced in assisting clients with all parts of the tip reporting process, from filing and supporting the proper tax reporting forms to negotiating controversial issues with the IRS.

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